VAT consequences when a VAT-registered entity imposes penalties and fines

VAT consequences when a VAT-registered entity imposes penalties and fines

Question:

What are the VAT consequences when a VAT-registered entity imposes penalties and fines?

Answer: In some instances, ‘user fees’ would be the more appropriate description of the transaction. Library fees (usually prescribed by Municipalities) provide for a period of free borrowing.An overdue fee is charged when the period of borrowing is expired.This is not a penalty for an offence but a payment for extended borrowing and is vatable.In the United States, late payment penalties are part of the consideration (and are vatable) set under the rating powers Act, and are not fines imposed.

Another useful tax case law relates to a club that hires out video to its members for a fee.In accordance with the rules of the club the video shop charges members an extra amount if a video is returned late. In this instance, the `fine’ comprises additional consideration for the hire of the video and is therefore vatable.

So this raises the question: When an entity imposes a fine or penalty, should it charge VAT on the fine or penalty? A fine or penalty can either take the form of monetary payment or it could comprise the suspension of privilege.

Generally, if a vat-registered entity imposes a fine, the transaction will be subject to VAT if the fine relates to a supply of goods or services.So, if a fine or penalty is not paid in respect of goods or services supplied, it will not attract VAT.For example, if a municipality imposes additional charge for excessive use of electricity, the `penalty’ relates directly to the supply of electricity and would attract VAT.

VAT is levied on the taxable supply of goods and services by a vendor.The term ‘taxable supplies’ includes all supplies made by a vendor - in the course or furtherance of its `enterprising activities’.The entity should have a constitution which lists its supply of goods and services. Only the listed goods and services are vatable.Therefore, payment will be subject to VAT if it can be linked to the consideration for a taxable supply by the entity imposing the fine or penalty. No VAT should be charged if a link is absent between the payment or a fine and the supply of good and service.

So, when a fine or penalty is imposed by the association on a member because of the member’s non compliant behaviour with the membership rules, the fine or penalty is essentially a punishment, or to act as a deterrent. In this case, when a citizen pays a fine or penalty, the citizen receives no additional rights, benefits or privileges to which that citizen was already entitled by virtue of membership of that association. Moreover, if the `fine’ or `penalty’ an ‘interest’ charge on an overdue account, the `fine’ or `penalty’ is the amount received for an exempt supply (financial service).

Therefore, it can be concluded that a registered entity will not account for output VAT if the fines and penalties are paid for the following reasons:

- To ensure compliant behaviour in respect of rules,

- The penalty or fine is paid as a form of punishment and no additional goods or services are provided as a consequence of this payment.

WHY REGISTER WITH SAIT?

Section 240A of the Tax Administration Act, 2011 (as amended) requires that all tax practitioners register with a recognized controlling body before 1 July 2013. It is a criminal offense to not register with both a recognized controlling body and SARS.